From Boom to Bust: Why China's Stocks Lagged Behind Its Economy and Where to Invest Next
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Welcome the money for the rest of us. This is a personal financial on money, how IT works, how to invest IT in, how to live without worrying about IT. I'm your host David stein. Today is episode four.

Forty five is title from boom to bus, why chinese stocks lagged behind its economy and where to invest next? We have recently have been working on adding secretly adjusted Price to earnings ratio or shelter PS to asset camp, our stock index reporting service. As part of the process, i've been working on the formulas to add to our database and ended up spending sometimes studying the long term performance of the chinese stock market and the underlying drivers.

I was shocked to see how poorly the chinese stock market has performed since the stock exchange was establish. Original stock exchange in china is the shanghai stock exchange, but IT was closed for decades from one thousand and forty nine when the people's republic of china was founded, appetite, november one thousand and ninety, when I was officially reestablished. Around the same time, the changing stock exchange opened in december one, nine hundred and ninety, the first chinese stock index that i'm aware of at least have data to is the msci china index.

IT began on december thirty first one thousand nine hundred and ninety two. At the time, beginning in one thousand hundred and ninety three, there were fifty three publicly listed firms trading on either either the shanghai or and stock exchange when they were reestablished. In the case of the shanghai index or brand knew the sheen index, in one thousand nine hundred ninety, there was only ten list s.

Now by one thousand nine hundred and ninety two, there were fifty three listings. That's the starting point over the next thirty point six years through last friday, August eighteen, twenty, twenty three, the msi china index has returned zero point seven percent analyzed in chinese one and zero point six percent analyzed in us dollars, less than one percent analysts return. That appears to eight point four percent for the global stock market in local currencies and eight point one percent in U.

S. dollars. That would be the msi all country world index. The stock market over the thirty year period has has returned ten percent. Analyst is absolutely amazing when you consider chinese economic output. It's GDP grew from nineteen and ninety two was at four hundred and twenty seven billion dollars, two eighteen point one trillion dollars today, economies forty two times larger, the second largest economy in the world, the overall size of the stock market as measured by market capitalization, which is a number of shares outstanding, times surprise, there's way more or stocks outstanding now.

And so the size of the stock market went from less than one hundred billion dollars in the early one thousand and nineties to twelve trained dollars today, yet investing in a chinese stock index mutual fund, or etf, has been incredibly disappointing, except for one amazing decade from two thousand one to twenty eleven. And this was the time that I was overweight china by way of being overweg emerging markets, both in my personal portfolio as well as in the institutional accounts that we managed at my old firm. F.

G. advisers. Batten appear was amazing because china outperformed the U. S. Stock market by over ten percent.

Analyst, when do we invest in an index mutual under etf, or investing in a basket of stocks that tracks some segment of the market? And the factors that drive those stock returns over time are the earnings, are the earnings growing and what percent of those earnings are being paid out and divided? So if the earnings are growing and the dividends growing? And so the long term driver of return is the divided yield plus the earnings growth plus any change in valuations as an investors choose to either pay more or less for those dividends and earnings.

S over the past thirty years, the aggregate earnings for the msi china index have not grown. Its bid flat now wasn't flat all time. They dipped and then they came back during that remarkable decade.

But if we look at the starting earnings amount back in one thousand and ninety two compared to today, it's about the same. The chinese stock market over that thirty year year, there has been three distinct phases. The first phase chinese stocks under performed from january first one thousand hundred and ninety three, right when the msci china index was established.

Through december thirty first two thousand, the chinese stock market fell about seventy five percent. The first earnings data I could get was october one thousand hundred and ninety five. And from then until the end of december two thousand, china's earnings fell ninety percent in that remarkable decade from january first two thousand one through june thirty, twenty eleven.

China's earnings then increased nine fold. They grew at an analyzed rate of twenty three percent, and IT was during that period that to msci china index return thirteen and a half percent analyzed compared to one point one percent for U. S. stocks.

Now the Price to earnings ure show of the china index fell during that time from forty down the twelve point six, so that was a drag on performance, but still with twenty three percent analyzed earnings growth, plus a two point two percent divided yield overall returns for thirteen and a half percent analyst. So that valuation decline caused about ten percentage points per year since then, though since june thirty, twenty eleven through August eighteen th, twenty, twenty three, the M C, I, china indexes return only one point six percent analyzed. That compares to the global stock market, which is returned just about eight percent analyzed over the same period.

Why such big swings IT has to do with the the overall economy and how that economy developed. The first stage of economic reform began in the one thousand and eighty. In one thousand nine hundred and seventy eight, virtually all companies in china were stayed owned enterprises, and then during the eighties, under the leadership of dying shell pin, state owned enterprises began to reform.

Some managers were given some autonomy and performance targets, and they were able to keep some of the profits depending on how the state on enterprised performed, but the incentive of just weren't quite there yet after so many years under state control, the state on enterprises accumulated very large loss, especially because they were facing more competition from foreign invested enterprises, as well as some businesses started up by some of the townships. The industrial output of state own enterprises two thousand nine hundred and seventy eight in thousand nine hundred ninety three IT fell from eighty percent of total output, down to around sixty percent. And yet there weren't any closures of the state on enterprises.

They were just nursed along, adding more and more dead as they incurred more, more losses. And some of those losses accured to investors because some of the state own enterprises started to be listed on stock exchanges, and IT was part of the fourteenth chinese communist party congress in one hundred ninety two that the central government endorsed the creation of the socialist market economy. So just giving managers more autonomy wasn't enough.

They wanted public ownership as one of the reform goals in the teeth party congress in one hundred and ninety seven state of enterprises recall a pillar of the economy, and the legal status of private ownership was formally endorsed ed by the new constitution in one thousand eight ninety nine two, one thousand hundred and ninety eight two thousand. The state, at a really a three year battle to restructure state on enterprises, there were layoffs began in one thousand nine hundred and ninety five, but IT was a huge period of restructuring, and IT was not a great time. We invested in the chinese stock market, as I mentioned, that they fell over seventy five percent during the is.

One of the interesting ways that china decided to develop is the central government wanted to retain control of the largest state on enterprises. The top one thousand, which were mostly in waterloo as upstream sectors. So oil and refinery companies, steel and chemicals, construction and infrastructure, power generation banks, railways, those remained under state controlled.

Even if they've had an initial public offering and public icy traded, the state still maintain majority control of those enterprises. That compares to the downstream enterprises were often smaller private firms, businesses in food and agriculture, beverages, text style manufacturing, printing, so businesses that in many regard drew upon the upstream companies that we're state control. There were more enterprises, private enterprises in the downstream companies by one, nine hundred and ninety seven and five hundred largest state of enterprises made up about thirty percent of state industrial assets and sixty three percent of state own enterprise profits.

Throughout that period of the nineties, there were more companies that went public, and by the end of the year two thousand, there were over a thousand publicly traded companies, many of them stay on enterprises, and the overall size of the chinese stock market was about six hundred billion dollars, or fifty four percent of china's GDP. When a chinese company wants to go public, IT needs permission from the china's security's relator commission. And there was actually a quote, a system saying, who could go public each year and the ownership that needed to be maintained by the state, the management generally, the academic studies that I saw that when the company went public, especially between one thousand nine hundred and ninety two thousand, when the stock markets severely under performed after the public listing, there was a determination and economic performance for up to six years, that the companies, even they were republic, they weren't discipline and they didn't do very well.

I took a long time after being stayed owned enterprises under communism to be hopefully a dynamic organization, even though the state maintain controls. And there was there's a lot of a baggage of inefficiencies from having a centrally managed economy. Many of those companies really had an experience ed competition, and there were governance issues, often misaligned ascents ves, or a short term focus that hurt the company longer term.

Clearly, there are some external factors in the ninety, such as the asian financial crisis, but the bottom line is, throughout this tumultuous period of the nineties, there were more publicly listed companies. There were index mutual funds investing in china, but it's severely under performed. Things began to change though, if ticket in two thousand, one when china was admitted to the world trade organization, that was a huge telling.

And there was an significant increase in china's working age population, more workers, and that contributed to a faster growing economy, particularly because now the world was open in terms of exports. The world trade org ization was established in one thousand nine hundred ninety five, and its purpose is to promote free trade, to reduce strait barriers. To become a member, you have to be admitted right now.

Others, around one hundred and sixty four members. One of the core principles is most favorite nation status, so treating all trading partners equally. IT was controversial to invite china into this partnership, especially considering the political background, human rights abuses. But they were admitted and he lit a fire.

Under the chinese economy, from ninety ninety two to two thousand, us imports from china grew from twenty five billion to a hundred billion, but then from two thousand and one to twenty eleven, after china was admitted to the debt to o imports. Into the us from china quadro pod from one hundred billion to four hundred billion. And then from twenty eleven, IT has slowed about five hundred thirty seven billion.

Today about one hundred and thirty seven billion increase, but that that period two thousand and one and twenty eleven, massive growth in exports, combined with a continuation of working population growth. Back in one thousand nine and eighty, there were six hundred million workers in china, age fifteen to sixty four. By the year two thousand, IT was over eight hundred million, but then grew to over a billion by tony eleven.

That growth in the workforce was parents due to a baby boom during the fifties and sixties. Recall that the one child policy in china wasn't introduced until one thousand nine hundred and seventy nine, and IT took a while for IT really to be enforced. So there was children being born in the nineteen sixties and seventies, and those children became of working age during the eighties, nineties and two thousands.

In addition, improvements and health care LED to increase life expectancy. So more workers, including workers that left the world's areas and move to the manufacturing centers in the cities. So big increases in exports, big increase in investments and infrastructure and building as the chinese economy modernized and IT helped the state on enterprises.

These upstream businesses, even though they didn't receded ily, increase their efficiency by much because the economy is growing so quickly with GDP growth over ten percent per year. They participated as the private companies and some of the other smaller companies publicly created, including would need to buy materials from the chemical companies. These upstream companies that didn't necessarily increase their productivity by much, but still vanish to do very, very well.

And some of those were publicly traded, and that's why the stock market did so well in the two thousands. Before we continue, let me post, share some words on this weak sponsors. Ever wonder how much of your personal data is out there on the internet for anyone to see more than you think, your name, contact and fill social security number and home address, even information about your family members.

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So visit Better, not come to get start, learn more about the highest cash accounts at veteran dot com, investing in all risk performance, not guaranteed cash reserves offer through Betterment L, L, C, and beaton securities veteran is not a bank. The third phase S, O, has been a struggle, as I mention that analyzed growth in the nexi china index has only in one point four percent annualized. Stone enterprises still play a very large role in china listed state, one enterprises make up forty percent of the chinese stock market.

There hasn't been any great reforms in these larger status enterprises. There's still not very efficient, especially compared to their international peers, and with the rise of china's president j. Japie, he wants to strength in those stayed enterprises, use them to advance the goals of the chinese communist party, which mayor may not be what is in the best interest of shareholders is also a big lack of transparently and some distrust.

There has not been more movement to privatize the economy to allow for additional competition, and as a result, we have these big lumbering state enterprises make up a meaningful portion of the chinese stock market. The chairman, the chinese securities regulatory commission e him on, told the forum last november twenty twenty two that there are efforts to quote, explore evaluation system with chinese characteristics. What that means is they want these publicly traded stone enterprises, which e saves, have a pillar role in the economy to sell for higher valuations.

In the stock market, there are too cheap, for example, china's communication construction, the stone enterprise was trading in late two and twenty two at a forward Price to earnings ratio of six point two. The china railroad group of four, A, P, E of four, they were cheap. And one of the things china did was had their government backed asset managers set up sixteen additional mutual funds with the Mandate to invest in state enterprises to try to push up the valuations of these companies.

There is over fourteen hundred stone enterprises listed in the chinese stocks mark, but some of that legacy inefficiency remains, and IT is held down the china's stock market, James woo, who is a shanghai based fund manager, said after selling many of his banking stocks, i'm not going to hold onto an investment only because the government says it's worth buying. There are Better investment opportunities than state banks that lack growth potential and independent management, so the stock market continues to under perform in the past decade because of inefficient state own enterprises, but there's also some structural headwind if the employment pull, the working age group is growing and they can sell out the rest of the world, that can must cover inefficiencies and state own enterprise. That's what happened between two thousand and twenty.

But now the workforces aging and expected to drop its basically flat line at a billion workers for the past decade. But now it's starting to fall. There's been much lower migration from real areas into the cities and there's been some geopolitical fracturing under cheat champing.

More pressure are on trade with china because they've got to be such a large percentage of trade of exports and ran such big trade and baLances, that country started pushing back. In addition, there's been other countries with lower Priced labors that i've been able to compete more effectively with china on Price. China is going through A A severe slowdown and demographics.

The number birds in china now is less than half of what I was seven years ago. Adam tu, who is a column y university history professor that specializes in economic crisis, said. We're witnessing a gear shift in what has been the most dramatic trajectory and economic history.

Speaking of china, during the period from one thousand nine hundred and eighty to twenty eleven, with a particular strong growth from two thousand one to twenty eleven. And I know in that account that we manage and my firm that double digit return of chinese stocks and emerging markets overall significantly helped our performance to allow list out perform because the chinese market, emerging markets so much Better than the U. S.

Stock market during that time, the workforce in china will start to shrink in the twenty thirties, which means in order to increase economic output, they have to increase productivity and innovation that I can just be adding more, more debt, infrastructure investment. And what interesting in this period is the government seems more tolerant of allowing slower economic growth. They're just not step begin in providing huge stimulus like they did during the pandemic or during the great financial crisis.

The response to what's going on now has been somewhat mixed, and we're seeing IT with manufacturing activity acting exports of falling. Youth unemployment has climb ed to his highest ever, twenty one percent in june for workers eight, sixteen and twenty four. And then the government just stopped publishing that data.

There's been some financial hits. Country garden holdings, one of the largest and strongest property developers in china, missed some payments on its debt and is nearing default. This was put out as one of the strongest property developers.

And so there is some financial strange in the property sector, china has experienced some deflation. There has been news reports about Prices falling. Now if you look under the heart, you'll see that most of IT was due to energy and food Prices falling.

That core Prices have actually held up, but china is experiencing economic slowdown much slower than IT has seen. And it's it's a combination of a slower workforce and a lack of dynamism, particularly as the chinese government places more constraint and Mandates on state run enterprises. So where are we going forward? The international monetary fund expects china's GDP to grow less than four percent in the coming years.

Capital economics, uh, research firm that we subscribe to seize the same thing and that the economic growth on a real basis could be as lowest two percent in two, two hundred and thirty, because we know economic growth as a function of is the worker in increasing, which is not in china, and how productive are they? Are they able to make more, produce more output with less resources to use innovation, technology? And so china's at risk at balling the meat president cheat chen pings, go of doubling the economy between twenty, twenty and twenty thirty five.

Not everything is bad in china. So fascinating. We have this huge economy. Its growth is slowing, but it's still in emerging market economy.

Income per person in china is only about thirteen thousand dollars compared to seventy six thousand in the us and forty two thousand in japan. There is much more development that could occur. So even though economic growth is slowing, it's not gonna go away.

China, they'll continue to grow at four percent, maybe less, but IT will be growth, and we can see that and how quickly china is adopting elector vehicles and installing renewable energy infrastructure. China's new solar power production coming online in twenty twenty three at one hundred and fifty seven gigg watts. Just what's coming online this year will be larger than all of this solar capacity in the us.

At one hundred and thirteen gieger watts. So china is slowing, but we can't write IT off because they could increase productivity. Which would allow the stock market to hopefully do Better.

Right now we look at the Price to earnings ure ratio of the msci china index. It's fairly close to its average at fourteen point six. That's on a trail basis for we're looking into a ten point eight or the long term average eleven point seven, the divided yields two point four percent.

So if companies are that index could grow their earnings five percent that be a seven point four percent return. The five year every journey growth is around six point eight percent. So we don't know.

We'll see I continued to have investments in china, but IT therethrough w, broad based emerging markets, E, T, S, I still like emerging markets even though china is slowing because in aggregate, emerging markets continue to grow their economies or will faster than the developed world. Capital economics expects emerging markets to account for fifty eight percent of global GDP in twenty fifty compared to forty seven percent in twenty twenty two. The demographic headwinds in the develop world is much greater than in emerging market.

And there are some areas of emerging markets where the working population will grow dramatically in the coming decade, including nigeria, uga, kenya, tania, india, a place where I have investments that's expected to become the world's third largest economy by twenty thirty. And its working age population will surpass china by the end of this decade with over a billion worker. So india is an upt trajectory in terms of its working age population, and that's actually despite the fact that women in india most do not work outside of the home.

In other developing nations, you typically saw the female labor force participation rate increase, for example, in the U. S, I went from thirty two percent nineteen and forty eight to fifty nine percent in the year two thousand. In india, mostly due to cultural reasons, IT has remained around twenty four percent.

It's high was back in the year two thousand and eight, thirty one percent. Now it's twenty four percent. That's the twelve lowest in the world in terms of female participation in the workforce.

Yet despite that, the working age population in india will continue to grow and productivity is increasing. We look at what's happened in the digital payment space in india. There's been major innovations and productivity there.

The chAllenge with invested in india is is expensive because the the index, the M S india index, is dominated by some big technology companies. So they are they're expensive. So i've invested in india with the wash emerging india fund.

W A, I, N, X is buying high growth companies, and it's done well for me. I also have emerging market exposure through the western tree emerging markets, hy divided etf, D E M. This is also in our adaptive, more portable examples of money for the rest.

Plus this is underway, china, so china makes up about twenty nine percent of the overall emerging markets index. IT was forty percent, but now twenty nine percent. The D, E, M, with the dividend yield over nine percent, is about twenty three percent.

China, we're seeing china's weight in emerging markets drop over time, and that will continue as these faster growing economies and make up the emerging markets grow faster and grow profits faster and their stocks appreciate greater than china in china becomes a smaller percentage. And so we don't want to just like not investment emerging market as if we own a etf like vt. The vanguard world's stock market etf, IT has a meaningful exposure to margin.

Mark believe it's tens and I don't have in front of me, but we can participate by investing in the global stock market. We can add some additional emerging market opportunities through a specific emerging market etf like D M. Or we can invest in A A country specific fun like the wall, such emerging india fun.

I'm not come to investing in a china etf right now because of the headwind that we talked about. Those headwinds have had to basically a thirty year period of under performance relative to the rest of the world, and it's doubtful whether they're be able to turn that around. Those still grow, but this is not a high obtained, but some real changes need to be made because of the demographic headwinds.

That's a discussion of why china has under perform. There are still opportunities in emerging markets, particularly india and some other frontier markets. Thanks for listening.

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